Strategy & Competition

e-Books: Averting a Digital Horror Story

On Christmas Day, for the first time in its history, Amazon.com (AMZN) sold more digital books than the old fashioned kind. It was a watershed moment for the book industry—but it's scaring the hell out of traditional publishers. Even though they make the same amount on sales of both kinds of books, they see Amazon's digital dominance as a looming threat to their business, and with good reason. Their big worry: Amazon will end up with the same kind of pricing power in books that Apple (AAPL) has in music, and that the book industry will suffer the same kind of bruising decline.

One goal for publishers is to dilute Amazon's power. Hachette is selling e-books through more than a dozen partners, including Sony (SNE), Apple, and small retailers such as Fictionwise. By partnering with multiple outlets, publishers hope to regain control over pricing and gather purchasing data that could fuel future sales. They're unhappy Amazon has dropped the price of some new digital best-sellers to as little as $7.99, compared with $35 for hardcovers. Hachette and Simon & Schuster plan to delay the release of certain digital books for several months to avoid undercutting the sale of best-sellers. "We are giving away the family jewels," says David Young, chairman and chief executive of Hachette Book Group, which publishes authors Malcolm Gladwell and Walter Mosley.

Publishers are typically paid about half the hardcover's retail price, whether a digital book or hardcover is sold. But Amazon has been pushing to pay them less, and many publishers think cheap digital books will open the door to lower industry revenues in the future. Amazon, for its part, says publishers' concerns are overblown. "We are selling a lot of books for publishers. We feel like that relationship continues to be a good one," says Ian Freed, Amazon's vice-president for the Kindle business.

Several publishers are trying to reinvent their businesses before Amazon, or someone else, does it for them. "We are thinking very hard about what opportunities there are to prevent our business from being destroyed," says Young.

Next year Hachette is coming out with a digital version of Sebastian Junger's War that will include video clips, a first for the company. (The book, scheduled for release in May, is based on the author's reporting in Afghanistan and the footage will feature firefights and interviews with soldiers.) HarperCollins is selling a collection of classics on the Nintendo (NTDOY) DS handheld gaming device. Meanwhile, O'Reilly Media, which produces software user manuals, is testing completely new pricing schemes. Instead of selling individual books, it's offering unlimited access to 10,000 titles, videos, and pre-publication manuscripts on the Web for $42.99 a month. "Our mission is not making books," says Tim O'Reilly, the company's CEO and founder. "It's changing the world through spreading the knowledge of innovators."

Young believes people are interested in paying for variations on the standard book, say a single chapter or a searchable database. In late September, two authors, a few editors, and a technologist gathered in Hachette's New York City office to work on an iPhone application based on the popular food book, What to Drink with What You Eat. The heavily illustrated volume will have to be adapted for a screen smaller than a playing card. Gurvinder Batra, chief technology officer of Kiwitech, a Washington (D.C.) startup Hachette hired to develop the app, handed out printed shots of the screen and navigation. "To get to the right info I should not do more than two or three clicks," said Batra.

The team decided the app should be like a virtual sommelier cum food critic, featuring food and wine pairings and tutorials on flavor balancing. Then they moved on to the touchy subject of pricing: Should they charge for the app? Most iPhone apps are free or very cheap. "We are in publishing," said Siobhan Padgett, digital sales and marketing manager at Hachette. "We have to make money." The hardcover of What to Drink with What You Eat lists for $35, and the Kindle edition goes for $19.25. Hachette editors eventually decided to charge $4.99 for the app, which is coming out in January. "We think we can sell a whole lot of these at this price," says Padgett.

Hachette doesn't disclose how much revenue it pulls in from its digital efforts, but the company is doing well. Strong sales of Stephenie Meyer's Twilight series, Teddy Kennedy's True Compass, and Malcolm Gladwell's Outliers helped boost revenues 15% over the first nine months of the year.

Harlequin Enterprises, the 60-year-old publisher of romance novels, started offering all its books in electronic form in 2007 and is now experimenting with several new digital formats. One, called Spice Briefs, seeks to publish short-form erotica, running 5,000 to 20,000 words long, as e-books. Another involves publishing short digital prequels, which bring in extra revenue and tend to pump up print sales. Gena Showalter, a popular author of young adult novels, wrote a prequel for her Lords of the Underworld series that came out one month before the first print book and sold for $2.99. The book, The Darkest Night, debuted at No. 8 on The New York Times bestseller list and has sold 220,000 copies, vs. 130,000 copies of her previous book.

Harlequin CEO Donna Hayes says electronic books account for about 6% of total sales now, but she expects that to double in a few years. She says digital sales appear to be adding to the company's revenue, rather than cannibalizing traditional sales. Harlequin's revenues rose 7% over the first nine months of the year, while U.S. book sales were up 3.6%. "It has grown our business so far," says Hayes.

THE NETWORKED BOOKTim O'Reilly may be pushing experimentation further than anyone. His company's decision to sell monthly subscription access to all its user manuals and other materials has been a hit with companies, universities, and training organizations, growing to 20% of overall revenue. "We see ourselves as the canaries in the coal mine," says O'Reilly.

Today, O'Reilly is trying out several new digital products, including one he calls the "networked book," an attempt to get readers involved in the creation of books through interaction over the Web. The company began by letting readers review authors' original manuscripts several months prior to a book's publication and now is allowing readers to post comments on manuscripts.

In the company's San Francisco office, engineer Keith Fahlgren fired up his laptop to show off a Web site for a book called The Real World Haskell, a user guide for a computer programming language. Software that Fahlgren created let 750 people post 7,000 comments for the authors to read. Many reader postings influenced the final version of the book. "This chapter seems a little bit too much like an essay," wrote one reader. "Follow the old rule, show, don't tell." Co-author Bryan O'Sullivan wrote on his blog that the feedback had "a profound effect" on the book. "We have used your input to make our coverage both more correct and more accessible," he said.

O'Reilly and other publishers are cultivating Apple as an alternative to Amazon. One reason: More than 50 million people have the company's iPhone or iPod Touch, which can be used to read digital books, compared with just four million who have electronic book readers. O'Reilly says his company is generating far more sales from Apple customers than Kindle users. O'Reilly currently offers 500 books on the iPhone, compared with 350 Kindle titles. Another 500 iPhone titles are in the works.

O'Reilly is already reaping the benefits of his investments in technology. But Young and other publishers acknowledge they don't know how all this experimentation will pay off. Still, they know they need to figure out the digital future before they lose out to Amazon or another aggressive newcomer. "We've got a long way to go before we can recoup our digital investments. The costs have been huge," says Young. "But I am optimistic, provided we sustain a healthy industry."

Business Exchange: Read, save, and add content on BW's new Web 2.0 topic networkThe Debate over Book DelaysShould book publishers delay releasing the digital versions of popular books? There has been fierce debate over that question ever since the Hachette Book Group and Simon & Schuster said in December they plan to hold back digital versions of certain upcoming titles for several months after the hardcover's release. Nathan Bransford, a literary agent in the San Francisco office of Curtis Brown Ltd., argued against such delays on his blog, since he believes they will simply aggravate would-be readers. "We've seen repeatedly over the last decade, alienate digital consumers at your peril," he warned. "The best deterrent against piracy is making a digital edition readily available for sale at a fair price. Resisting the conversion to digital sure didn't work for the music industry."To read his blog post, go to http://bx.businessweek.com/e-books/reference/